Answer:
The pre-tax cost of debt is 6.75%
Step-by-step explanation:
In this question, we are interested in calculating the pre-tax cost of the company debt.
To calculate this, we use the mathematical formula below;
Pre-tax cost of debt = (WACC - equity/(value * cost of debt)) / (debt equity ratio/ value * (1-tax rate))
From the question, we identify the parameters in the equation as follows :
WACC is weighted average cost of company = 13.5%
equity = 1
value = equity + debt-equity ratio = 1+ 0.45 = 1.45
Cost of equity = 17.6%
debt-equity ratio = 0.45
Tax rate = 35%
Now, substituting these values into the equation, we have;
Pre-tax cost of debt =
(13.5%(-1/(1.45*17.6%)/(0.45/(1.45*(1-35%))
= 0.0675 or 6.75%
